Where next for inflation and prices in 2011?

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Data released today showed CPI annual inflation hit 3.7% in the year to December, well above the Bank of England's target rate of 2.0%. But it is not so much current inflation, as prospects for future inflation, that will be worrying the Bank.

There are certainly cost pressures in manufacturing: input prices are well and truly on the up. As we noted last week, commodity prices are putting pressure on firms. The Producer Price Index revealed that average input prices for manufactured goods rose 12.5% in the year to December. Oil prices accounted for a fair proportion of this rise, but imported metals prices were also up significantly, by 24.2% over the year. Even excluding more erratic items, costs were up by 8.8%.

Output prices are also rising, though they have failed to keep pace with input prices: the average output price for home sales of manufactured goods was up 4.2% in the year to December.

This discrepancy will be putting pressure on companies' margins (though there are other factors to consider such as export prices and wages), and it is therefore not surprising that in EEF's last Business Trends survey we saw a jump in the number of companies planning to put up prices, both in the UK and abroad.

What does this mean for broader inflation?

Obviously UK-manufactured goods do not make up the entirety of the basket of goods and services consumed by a UK household which are used to calculate. Goods consumption makes up about half of the weighting in the CPI, and although it is impossible to separate out UK-produced consumption from this, it is fair to assume that there will be similar price pressures on imported goods.

Figure 1: CPI inflation (annual % change)

Given strong growth in emerging economies, input-price pressures seem unlikely to abate. If commodities prices rise at the same rate that they did in 2010, we forecast that CPI inflation in the UK will remain above 3% for all of 2011 and above target for all of 2012. Today's inflation outturn suggests this is not implausible.

The Bank of England is right to hold back on rate rises, worried as it is about the impact that spending cuts will have on economic growth, but the uncertainty inflation causes is not good for growth either. Our forecasts suggest that with higher commodity-price-fuelled inflation, manufacturing output growth would be reduced.


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